I am a registered investment advisor based in Houston Texas, specializing in equity options. My focus is naked put selling and spread trading. I have past experience in commercial banking, real estate, and oil and gas, as well as various types of other derivative investments. My world was turned upside down by the financial crisis of 2008-9. Many of my views are slanted to expose and correct the corruptions existing in the world’s financial markets. I have a BS in economics from UC Berkeley and an MBA in finance from the U of Pennsylvania Wharton School. Reach me at rbf10@comcast.net

Meet The New Subprime: It Will Cost Us Billions

When will our government come to realize that not everyone in this country can own a home? Not an issue of cruelty or insensitivity or lack of dream for Utopia, but a simple matter of economics. Not everyone has 20% or even 10% to make a bona fide down payment and have the subsequent income to comfortably service the debt. Apparently the continuing pain of the subprime crisis has taught our feckless politicians nothing. While sub-prime has morphed into a naughty word, a near clone has stealthily infiltrated the mortgage markets, choking the breath out of many unfortunates ensnared by its enervating tentacles. Meet the Federal Housing Administration or FHA. It found life under Roosevelt in 1934 as part of his alphabet soup answer to extricate America from depression. It started as a benign institution, and like today, insured loans and offered some down payment relief to borrowers.

Why Has FHA Become A Monster Now

Last November the Department of Housing and Urban Development (HUD) under whose purview FHA falls, issued the September 30 fiscal year 2011 annual report. It was a rather damning indictment. Capital which is statutorily set at 2% of assets had fallen to a measly .24% or from $4.7 billion in 2010 to $2.6 billion in year end 2011. It is only a mere $20 billion shy of requirement. This capital is expressed as the MMI or Mutual Mortgage Insurance Fund or the backstop to any defaults on the $1.1 trillion of FHA insured loans outstanding. The auditors estimated $26 billion of losses for loans underwritten through the first quarter of 2009 and another $14.1 billion for “seller funded down payment assistance loans”. Though since curtailed, the seller used to be able to loan the purchaser most or all of the down payment leaving the buyer with little or no “skin in the game.” Then the auditors sang the praises that the 2010 and 2011 books of business will be profitable, and put new risk guidelines and credit policies in place so all is well and they expect to be in capital compliance by 2015.

A large part of the problem is that to qualify for a mortgage at FHA you need little more than an active “pulse”. Requirements have been repeatedly watered down. The down payment requirements are 3.5% with a credit score of 580. A score below 640 is considered subprime by the Federal Reserve. When you roll in the insurance fee into the loan balance you have a loan to value ratio that starts at over 98%. The paltry down payment may be funded by relatives or employers. It gets more bizarre. Borrowers can claim income from a roommate (to be found at a later date) to help qualify for the loan. Often no cash reserves are required to demonstrate ability handle repair bills and taxes and still meet mortgage obligations. In addition, when you default you just go and apply to the pernicious Home Affordable Modification Program or HAMP which is designed to give our beleaguered mortgagor several more bites at the apple. His or her loan will be modified (interest rate reduced or principal forgiven) and because of new more lenient HAMP rules, when she or he defaults again, the loan can be rejiggered yet one more time. All the income requirements at HAMP have been reduced more than once. HAMP also has one of those goofy phantom roommate clauses.

The contrast between FHA and Fannie Mae tells the story. First Fannie Mae issues what are known as conforming or “conventional” loans which have such requirements as 20% money down and cash reserves for repairs as well as infinitely stricter income requirements than FHA. Second, and insidiously, FHA now has a loan limit that is higher than Fannie Mae. Ex Alaska and Hawaii, FHA has loan limits up to $729,750 while conventional mortgages are stuck at $625,000. So in effect there has been a “disintermediation” away from Fannie and into FHA. If you have little cash the lax requirements of FHA is the siren call. This is borne out as FHA has increased threefold in size since 2005. And combined with HAMP a borrower has multiple opportunities to default with impunity, the system encourages irresponsible behavior.

Realizing that perhaps this Ponzi scheme can’t endure indefinitely, FHA has raised their insurance premiums to borrowers twice this year, most recently with Congress giving, with a 402-7 vote, it’s imprimatur on the FHA Fiscal Solvency Act which raised cost of insurance to up to 2.05% annually. The bill announced more hollow risk guidelines and even hired a new risk officer to make sure all roommates are in compliance. HUD Secretary Donovan emerged from his cave and hailed this would ensure the solvency of FHA.

Meanwhile, economists at the Federal Reserve were crunching some numbers of there own. FHA has for years underestimated their losses from claims on defaulted loans. It turns out that every time FHA has a loan default but it gets modified into a new loan, then this loan is a success and hence not counted as a defaulted loan. In fact, this default is a default and not a success and to the extent it has been modified (lower interest or principal) it cost me and you the taxpayer, money. Additionally, it was discovered that 49% of all reworked loans defaulted a second time within twelve months. The bottom line is FHA uses a faulty econometric model that vastly underestimates defaults to forecast losses. The Fed, which used actual FHA loan data from 2007-2009, predicts there will be a 30% default rate on these loans within five years.

Some Mind Blowing Statistics

So on the one side of the aisle sits HUD secretary Donavan pontificating all is well in FHA land, while on the debit side of the ledger the Federal Reserve has produced a significantly less sanguine vision for the future. Skeptic that I am, I tend to believe half of what I see first hand. Ergo, I embarked on a little sleuthing mission to compare the credibility of each stance. Locating the latest 10Q’s (second quarter 2012) for JPM, BAC, and WFC, I combed the nether intestines in search of their FHA loan exposures and what is the current delinquency experience. Sobering understates the resulting data. BAC, far and away the largest FHA lender of the three has a $67.3 billion book of which $18.1 billion or 26.9% is 90 days or more past due. It gets worse. Government guaranteed loans at WFC total $28.43 billion and a whopping 69.3% fall into the 90 day overdue basket. JPM brings up the rear with a comparatively small $15.9 billion but with an incredible 74.8% being derelict by three months or more. When you add up these three lenders you arrive just under $112 billion or 10% of the total $1.1 trillion FHA insured market. Take my word, in aggregate the math and division yields that nearly 45% of all of these FHA insured loans are three payments or more behind. That is $49.5 billion of loans more than three moths past due. The FHA has $2.6 billion in capital. Can we extrapolate to the other 90% of the market? Who knows, but these three banks have operations covering areas in excess of 95% of the population of America.

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This article highlites more than the subprime dilemma but a general sentiment shift that everyone is equally deserving of everything. There are more government entitlement programs now than ever before. Additionally, the government is a poor example of how to lead its people when it cannot manage a budget without constantly spending more and more.

Don’t forget that the gov. is also loading the electorate with quasi-legals like anchor babies, who then absorb the benefits that they never paid for and supplant US citizens (who did pay) from both benefits and jobs. Here in CA Jerry Brown just signed into law a bill letting illegals get drivers licenses (it ain’t so they can arrest them at the DMV). The effectis to load the voter rolls at the bottom – more people to buy votes from, most with very little clue of what is happening. It’s the ultimate political con – create a dependent class, snow them with bribes to STAY IN OFFICE and create a dependent class.

I did not mention it in the article but you are spot on. The fact that you can default on your mortgage several times with basic impunity is definitely a vote buying scheme. This administration foments class warfare like no other in our history. Thanks for your comment. Richard

Richard, everything u said us true, but what about the millions of people trying to sell homes right now? Homes that wont sell because; A. creditors wont /cant loan without perfect credit. B. No one is buying homes because of the new economy (depsite what youve heard/read, the house i used to rent is still for sale two years after i moved, and there a many houses in my neighborhood available) and C. everyone who is selling their house doesnt realized THEY OVERPAID, im not giving you what u paid 30 years ago because U OVERPAID! Its very simple you have a house for sale, u put too much value in it for sentimental reasons, and YOU, the homeowner, bought into the “american dream” of home ownership,so now you have a house you overpriced it. One more thing about the “american dream” of home ownership,if i buy a home for 100,000$ in Houston, and in 30years ive paid 200,000$ in interest,ive basically paid 300,000$ for a home i cant sell for 100,000$, so wheres the advantage? after ive fixed the foundation ,roof, replaced water heater ,etc, I own something ive lost money on? yes the interest is tax deductable, but not 200,000$ worth!! That doesnt cover interest or maintanence!!!

Simple the bank takes a bath (or the government) and perhaps folks will learn their lesson. Not everyone should own a home but many don’t want to admit it. Nothing wrong with renting I did it for many years. We don’t want to loan money to folks who probably won’t pay back on houses valued more than they should be.

Well said. Didn’t Toqueville add that the end occurs when more than 50% are on the dole and therefore will vote to keep it that way. Right now, 55% of Americans recieve some sort of government assistance up from 40% when the current administration took office. We are daily more like Europe. Thanks for your comment. Richard

This is beyond insanity! It goes beyond doing the same thing the same way over and over and expecting different results. They double down or triple down on the effort and take even more extreme measures in the same bad direction to avoid the pain of failure. This is the kind of thing that lack of personal risk and accountability produce. When you can hide it from the public it’s a virtual Utopia for the inept. Student debt is becoming this same kind of huge problem. People take on huge debt and seek to avoid the pain of repaying it and think “the government” should do it for them.

You wrote, “The sense of responsibility to pay back a debt incurred is gone.” Sadly, that has become epidemic everywhere.